The SEC is aiding and abetting high frequency traders

The SEC needs to put the SEC on its list of entities to investigate when it comes to high frequency trading.

On Wednesday, The Wall Street Journalreported that a pair of recently released studies showed that the Securities and Exchange Commission is allowing high frequency traders to get sneak peaks at corporate financial fillings before the general public. The lag time between when the high frequency traders—or, more accurately, their computers—get the filings and the rest of the public is at most a minute, and often as little as 10 seconds. Still, the authors of the studies maintain that even a 10-second head start is a big advantage for the computer traders, who measure trade times in milliseconds.

One of the studies found that when good or bad news (so, really, news) got to high frequency traders before others, stock trading volumes in those shares tended to jump. According to the WSJ, the findings suggest the regulator’s own system is giving professional traders an edge over mom-and-pop investors. Ouch!

An SEC contractor charges direct subscribers about $1,500 a month to access this feed. “The SEC receives no fees from the EDGAR Public Dissemination System (PDS),” says a spokesperson for the regulator. “The SEC does not pay the contractor to run and maintain PDS, nor does the contractor pay the SEC to run and maintain PDS.”

The SEC says about 40 companies subscribe to this service, most of which are data services or websites that publish the information they get from the SEC, and then give access to the information to their own subscribers. One of the subscribers to this service is Morningstar.com, which runs a website geared to average investors. Another is the Washington Service, which has hedge fund clients, including one that uses “quantitative models to drive trading strategies,” which sounds like it could be high frequency trading, but it could also be a lot of other things.

The story is not all that different from a number that have come out about high frequency traders over the last year or so. HFT traders agree to pay for a service—like having their computers closer to an exchange’s servers, or a slightly shorter data line between Chicago and New York, or early looks at the consumer confidence report or press releases—that the rest of Wall Street, and perhaps the service provider itself, assumes is worthless. And that goes on for a while, until someone figures out that that small advantage is worth a lot, if you are a high frequency trader. Outrage and, at times, lawsuits, then ensue. Usually, the service provider is forced to stop providing the special access to the high frequency traders (which, like plenty of other special services in all fields, the high frequency traders are paying a high fee for) because it seems unfair.

The difference here is the entity handing out that advantage is the SEC, which is supposed to regulate the market, should know something about what would give the HFT firms an advantage and is charged with making sure markets are fair. So, on the face of it, this looks bad, not just for us individual investors trying to compete with high frequency traders, but also for the SEC.

However, SEC documents are typically hundreds of pages long and written in legalize. The most important financial information, earnings results, are typically released by companies in press releases long before they are filed with the SEC. It’s not typically information that computers can digest quickly. But there are exceptions. One study looked at filings of insider transactions—when executives trade in their own shares. That’s something that is first reported in SEC filings.

It’s not all that surprising that the SEC would be slow to realize that selling a service that was giving an unfair advantage to high frequency trading was a bad idea. Then again, I bet that the SEC was unaware it was actually handing out an advantage. But even the SEC should have realized that the optics of actively assisting HFT firms would be bad.

Still, the SEC has been helping HFT firms in less direct ways. Despite harsh speeches from SEC Chair Mary Jo White and a few fines, the regulator has been slow to curtail high frequency trading. The SEC knew about the issues in Michael Lewis’ Flash Boys, which contends that HFT has rigged the market against individual investors, long before the book came out. Many of Lewis’ sources went to the SEC with their information long before they started talking to the journalist.

The SEC’s response? “Meh.” That might not be just because the SEC is a weak regulator. It comes down to the differences between what Lewis and the SEC think is important. If your No. 1 care is that the market be a fair and a level playing field, then Lewis’ outrage seems on target. High frequency traders do have an advantage.

The SEC, though, seems more concerned about bringing down the cost of trading. And at least in the ways that are easy to measure—trading costs, or the spread between what buyers pay and sellers get—high frequency trading does appear to have lowered costs for the average investor.

Of course, that’s not the only way to measure fairness, but it seems like a reasonable one, and an achievable one. That’s different than Lewis’ fairly naive notion of fairness, which I guess is that the market should be a completely level playing field between even the most sophisticated of high speed computerized professional traders and a guy like me with a Vanguard account.

Someone is always going to have an advantage. Even if the SEC did distribute its filings to Average Joes and high-speed traders at the same time, their computers would still be able to trade far faster than regular investors like you and me could even blink. HFT firms trade in milliseconds. I haven’t made a single trade all year. High frequency traders invest millions of dollars for the technology to be able to take advantage of that single-minute lead. I pay nothing to get access to my Vanguard account.

But the general public is not going to understand that last part, which is really the heart of the SEC dilemma when it comes to figuring how it should regulate high frequency trading.

If you believe that lowering trading costs is the most important thing, and that HFT firms lower trading costs, helping HFT firms is probably the fairest thing you can do. Until, of course, the The Wall Street Journal or Michael Lewis finds out about it. Then you have to stop, and the SEC surely will, because, to the average investor, this is never going to seem fair.

Editor’s note: A previous version of this story incorrectly stated that the SEC provides a subscription service to a direct feed on corporate financial filings. In fact, the feed is provided by a contractor of the SEC. The regulator does not receive any remuneration from the contractor that operates this feed.

BATS President William O’Brien quits exchange operator

BATS Global Markets, one of the country’s largest stock exchanges, said Tuesday that its president, William O’Brien, is stepping out of that role, effective immediately.

In a press release, BATS gave no reason for O’Brien’s departure, which results in CEO Joe Ratterman reassuming the dual President-CEO title at the Lenexa, Kansas-based exchange. Ratterman previously held both titles until the BATS board decided to split the roles two years ago following the exchange’s withdrawal of its initial public offering due to a trading glitch.

O’Brien assumed the role of president roughly six months ago after previously serving as CEO of New Jersey exchange Direct Edge, which merged with BATS earlier this year.

In April, O’Brien made headlines when he appeared on CNBC and engaged in a heated argument with Flash Boys author Michael Lewis and IEX co-founder Brad Katsuyama, who is the focus of Lewis’ best-selling book and an outspoken opponent of high-frequency trading. The debate, which centered on how Direct Edge priced its trades, resulted in BATS issuing a correction of statements made by O’Brien during the interview in which he claimed the exchange did not use slower feeds for pricing.

Senate panel backs high frequency trading, and gets nowhere

The United States Senate took on high frequency trading and lost, I guess. Well, it didn’t win.

On Tuesday, the Senate Banking Committee held a hearing on the controversial trading practice. The hearing featured a number of boldfaced Wall Street names, including hedge fund titan and sometime-high-frequency-trader Ken Griffin; Jeff Sprecher, the head of the company that owns the New York Stock Exchange; and Joe Ratterman, the CEO of BATS, the stock exchange that is one of the chief “bad guys” featured in Michael Lewis’ recent book on HFT.

All of them said that high frequency trading is good for the market and should not be banned. The hearing contained no information to refute those facts.

Even Senator Elizabeth Warren took a shot and missed. Warren asked Griffin, just for context, how profitable his high frequency trading fund was. Griffin said he didn’t have a high frequency trading fund, which is technically true. He’s got a tactical fund that used to be all about high frequency trading but now is bigger and does a bunch of things, only one of which is high frequency trading. So it’s not solely a high frequency fund. Question deflected.

Griffin said we need high frequency trading to keep prices of exchange traded funds fair and accurate. But there have been lots of instances in which ETFs have been mis-priced. And shouldn’t making sure ETFs work be the job of BlackRock or others who rake in billions of dollars a year on such products?

There were even some swipes at Michael Lewis and his recent book Flash Boys, which vilified HFT. Griffin said the author had never spoken to him. Sprecher in a backhanded compliment said he admired IEX, the trading venue whose head Brad Katsuyama comes across as the hero of Lewis’ book. “I very much appreciate the IEX exchange, they have four order types,” Sprecher said. “I would love to get to four order types. They also have less than 1% market share.” The market, Sprecher was saying, has spoken, and they don’t want IEX.

All of the participants called for more disclosure of the fees that brokerage firms collect when they decide where to send their clients orders. They all agreed that there are too many places where stocks can trade, creating a potential for investors to get ripped off or for another so-called flash crash.

In fact, there seems to be a growing consensus from law makers and regulators, who are likely being guided by people like Sprecher and Griffin, that the real problem with the market is complexity; not lightning-quick trading that may or may not be picking investors’ pockets. Both Griffin and Sprecher said dark pools should be subject to the same regulations that exchanges are subject to. Sprecher says he would like to eliminate the fees that traders and brokers are paid to trade at one exchange over another.

All of those changes sound reasonable. But people who are likely to benefit the most from those changes are people like Sprecher and Griffin. The NYSE and trading venues like Griffin’s have to pay those fees. And, of course, Sprecher would like to go back to the days in which the market was simpler. Back then, the NYSE handled 90% of the trading volume.

Dark pools were formed, with different rules, in part because institutional investors thought they were not getting a good deal on exchanges. And there are “fair” dark pools, like IEX. But as Sprecher pointed out, no one trades there.

In the quest for talent, why Silicon Valley could trump Wall Street

FORTUNE – In a post-financial crisis world, it’s easy to hate on Wall Street. But what I’ve been looking for is a rational explanation — what exactly has gone so very wrong over there?

In Michael Lewis’ new book, Flash Boys, the author provides the most compelling answer I have found – much of Wall Street suffers from a complete and utter lack of mission. The book provides a powerful cultural critique.

John Doerr, one of venture capital’s legends, has a memorable saying: He only backs entrepreneurs who are “missionaries” not “mercenaries”. This is a key part of his investment thesis.

The difference? Mercenaries are in it for themselves (usually money). Missionaries are in it to change the world around them for the better.

The Bay Area is chock full of mission-driven companies. It’s easy to satirize Silicon Valley’s over-earnest desire to ‘change the world’. It’s also fair to ask if the desire is disingenuous, since ‘change’ doesn’t necessarily imply ‘for the better’. But the real question is, does a company’s mission actually matter?

One clear way a mission pays off is in helping a company recruit top talent. Despite public perception of how easy it is to win at startups in Silicon Valley, there is not a monetarily rational reason for the accelerating brain drain of some of our most educated, financially well-positioned future executives from Wall Street to Silicon Valley.

Employee compensation at Google GOOG (including stock grants) averages about $190,000 at a year while at Goldman Sachs GS it’s north of $500,000. The odds of striking it rich at an early stage startup are amazingly low. For talented money-seekers, Wall Street remains a relative sure thing compared to the risks of a startup.

But after reading Flash Boys, the trends we’ve being seeing lately at some of the nation’s top business schools makes perfect sense. At the University of Pennsylvania’s Wharton School, for instance, the percentage of MBAs entering investment banking dropped to 13.3% last year from 26% in 2006. During the same period, those entering tech more than doubled to 11.1%.

It’s easy to see why Wall Street could lose talent to Silicon Valley. Who would want to work in an industry where the only acceptable answer to the question “Why?” is “for money.” Past a certain threshold of earnings it makes rational sense to optimize for more than just money. Another way to look at this: Picture two recent MBAs at Thanksgiving dinner. One works for Google, bringing self-driving cars to the market; the other works at Goldman. Who is going to talk proudly about their job, and who is going to sheepishly avoid the subject?

A company mission provides a purpose; it forms a connection between a company and their customer. Missions make companies worth working for. The most successful Silicon Valley companies almost universally exude a sense of mission (think Apple AAPL, Salesforce.com CRM and Google), while the vulnerable incumbents have lost their sense of purpose (think HP HPQ and Microsoft). Microsoft resoundingly achieved their mission of ‘a new computer in every home,’ but must now find a new calling to stay relevant.

In the absence of mission, companies devolve into uninspiring backwaters with no purpose and little connection with their customers. They become the kind of companies that would screw over their customer to make profit in the short term at the expense of everything and everyone else. In the fullness of time, and provided an even playing field, I believe all mercenary companies will be out-competed by missionaries.

There is hope for Wall Street. The story in Flash Boys centers on the improbable founding of the stock exchange IEX. Brad Katsuyama founded IEX with the mission to bring transparency and accountability back to the stock market. The team overflows with Silicon Valley’s brand of tech-startup missionary zeal. Flash Boys tells what happens when their business and mission collides solidly with Wall Street’s mercenary culture. It’s an amazing story.

IEX’s journey is an improbable one. Their odds are no better than the average startup. I’d bet on them though, IEX has a powerful mission.

Zachary Rosen is co-founder and CEO of Pantheon, a San Francisco-based company whose professional website platform lets developers, marketers, and IT users build, launch, and run all their Drupal & WordPress websites. Follow him @zack.